The Fed's "internal debate" has become public, with Waller refuting Warsh's approach of weakening forward guidance.

A public debate is taking place within the Federal Reserve regarding how to communicate monetary policy, with the core of the disagreement being: how much forward guidance should the central bank provide to the market?

Wall Street Insights noted that Federal Reserve Governor Waller spoke at an event hosted by Reuters on Thursday, specifically outlining his stance on central bank communications. He stated that effective monetary policy communication should revolve around three objectives: the current policy stance, the policy outlook, and forward guidance under specific circumstances.

Waller's explanation echoed the "play the game, not watch the referee" analogy previously used by the new chairman, Warsh. Warsh's original intention was to encourage investors to pay more attention to economic data trends rather than focusing on the Fed's policy path itself, which was widely interpreted as a clear rejection of forward guidance.

Waller countered by using the analogy of a "strike" in baseball, arguing that the market doesn't need umpires to make mechanical judgments on every pitch, but it must have a basic framework of expectations regarding "what is a strike and what is a ball".

Warsh softened his tone in his speech at last week's Jackson Hole symposium, more explicitly emphasizing that the Fed would take action against inflation above target, but still insisted that the Fed could not yet "provide a mechanical, tried-and-tested answer."

When asked during the annual meeting whether he participated in the Fed’s newly formed communications task force, Kansas City Fed President Jeffrey Schmid replied “not really,” further highlighting the limitations of internal coordination.

Walsh's "playing" logic: downplaying forward guidance

Walsh's analogy of "focusing on the game, not on the referees" proposed in July is essentially a critique of two types of tools: one is an overly explicit reaction function (such as a policy response that strictly follows the Taylor rule), and the other is forward guidance in the conventional sense.

Warsh's logic implicitly suggests that over-reliance on forward guidance weakens the Federal Reserve's ability to respond flexibly to data and could leave the central bank in a passive position when the economic situation changes rapidly.

Warsh had previously pledged to reform the central bank's communication methods, including eliminating forward guidance and reducing the number of speeches and official statements. This strategy was criticized by bond investors in July, who argued that Warsh had failed to provide sufficient information about the economic outlook.

Waller holds reservations about this. His view is closer to the traditional central bank communication philosophy, which holds that transparency itself has the functional value of stabilizing expectations and reducing market volatility.

He does not oppose giving referees some discretion, and acknowledges that forward-looking guidelines are not always applicable.

However, he believes that a completely vague policy framework is equally harmful to the market. His baseball analogy emphasizes that market participants need a "rough outline" of the Fed's response function—that is, how far inflation or employment deviates from its target before the Fed typically takes action.

He emphasized that clearly communicating policy direction to businesses and households helps provide the public with clearer expectations. Waller stated:

But I think it should be used when it is truly needed.

"Internal family disputes" reflect greater uncertainty.

Walsh himself characterized the discussion as "a family debate."

However, this debate is unfolding in the form of public speeches in front of the market, and its impact has gone beyond the scope of internal discussions.

At the same time, the bond market is in a highly sensitive state. Global yields have risen to their highest level since 2008.

U.S. Treasury Secretary Bessenter announced an expansion of the long-term U.S. Treasury repurchase program, sparking widespread discussion in the market about the boundaries of policy tools.

Warsh's stance on pushing the Federal Reserve to shrink its balance sheet, coupled with the aforementioned pressures in the bond market, has made the market's demand for clarity in the Fed's policy communication increasingly urgent.

Before the Federal Reserve has a unified internal communication framework, investors may need to "play the game" and "keep an eye on the referee" at the same time—after all, even the referee himself is still discussing where the good ball zone should be marked.

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